Thursday, December 9, 2010

It is a bit bemusing to hear all this talk about the "only choice" we have is to continue to bail out countries so that we don't cause a panic blah blah. Bail out countries really means bail out bondholders - which are mostly the global banking giants. Yes some individuals also own sovereign debt, but frankly as hard as it is so believe in the current central bank backstopped world investments come with both risk and reward. I know Ben Bernanke would currently have you believe otherwise.

I mentioned yesterday that Iceland has recently emerged from recession after a very dark period, but has chosen the route of protecting its populace (the taxpayer) from absorbing more debt so that the global banking oligarchy may be made whole. This is in contrast to what other nations have been doing which is along the lines of the decisions in Ireland over the past 3 years - that is (a) first shift the debt from the banks from the private sector to the public and more recently (b) accept bailout funds - that eventually need to be paid back - to keep the whole thing from collapsing.... but to make the global banking oligarchy fat and happy as they suffer no losses.

In more simple terms

Iceland - take some very severe one time pain as country pays for excesses, but emerge with a clean slate and limited liabilities for the taxpayer, while the bondholders of debt (in this case Iceland's banks) take the hit.

The solution the rest of the world is taking - save the banks from any losses on either bonds of the banks or sovereign bonds, and by doing so combat a debt problem at the public level with more debt, kicking the can down the road, and imposing severe terms on the taxpayer, not to mention generations of debt service that will only grow in the decades (and in some cases centuries) to come. We are using Ireland in this example but many countries are variations of Ireland.

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Now again, it is not quite so simple as the 2 choices above because many countries in Europe are in a common union AND if much of the sovereign debt is held by banks. Who are now experts at holding the world hostage. If we impose losses on the banking oligarchy, they will claim we need to rescue the banks with taxpayer monies. In reality banks can go out of business - it happens every Friday in the US of A as the FDIC swoops in and closes banks and hands their assets to stronger firms. JPMorgan .... or Bank of America... or whomever - could go out of business and the U.S. would not be wiped off the face of the earth, contrary to popular belief. Same with Societe General in France or any major German Bank. As I proposed a few years ago, the government back backstop the deposits (rather than the bondholders) so there is not a banking run and temporarily raise FDIC insurance to any figure they wish - go to $10M, $50M, $100M - whatever.

Impossible you say? We did this with General Motors (and Chrysler) and that was probably the only 'rescue done right'. Bondholders took a big hit on their investments, management was escorted out the door, debt was (mostly) wiped out, equity holders lost all their money - but the company exists and churned out cars every day during its bankruptcy. Just as a bank could operate under bankruptcy terms with government backstop on deposits - until it is sold off into pieces to stronger players. Or our GSEs of mass destruction otherwise known as Fannie Mae and Freddie Mac (who have sucked hundreds of billions of the taxpayer's monies up). But to listen to the oligarchy and political tag team, we can't let that happen. Nope - the taxpayer must make sure the banks are backstopped and holders of debt can never take a loss - they have riskless investments, paid for by the global taxpayer.

But whose shoes would you rather be in right now? Those of Iceland or those of the Spanish/US/Irish/Greece/Japanese/Portuguese/Italian/British (and the list is growing) cabal? These are the questions the global taxpayer should be asking, instead of rolling over and accepting what the politico-banking duo demands of them under guise of fear mongering.

Iceland has finally emerged from deep recession after allowing its currency to plunge and washing its hands of private bank debt, prompting an intense the debate over whether Ireland might suffer less damage if adopted the same strategy.

The Nordic economy grew at 1.2pc in the third quarter and looks poised to rebound next year. It ends a gruelling slump caused largely by the "New Viking" antics of Landsbanki, Glitnir and Kaupthing, the trio of lenders that brought down Iceland's financial system in September 2008.

This has led to vastly different debt dynamics as they enter Year III of the drama. Iceland's budget deficit will be 6.3pc this year, and soon in surplus: Ireland's will be 32 pc (with bank bailouts contributing 20 pc); 12pc excluding bailouts and not much better next year.

The pain has been distributed very differently. Irish unemployment has reached 14.1pc, and is still rising. Iceland's peaked at 9.7pc and has since fallen to 7.3pc.

The International Monetary Fund said Iceland has turned the corner, praising Reykjavik for safeguarding its "valued Nordic social welfare model".

"In the event, the recession has proved shallower than expected, and Iceland’s growth decline of about minus 7pc in 2009 compares favorably against other countries hard hit by the crisis," said Mark Flanigan, the IMF's mission chief for the country.

Total debt will peak at 115pc, before dropping to 80pc by 2015 in what the IMF called "robust debt dynamics".

Meanwhile. Ireland's debt will continue rising for another three years to 120pc of GDP.

The contrast will be very starkby the middle of the decade. Iceland may have a lower sovereign debt than Germanyby then.

Iceland's president, Olafur Grimsson, irritated EU officials last month when he said his country was recovering faster because it had refused to bail out creditors – mostly foreigners. "The difference is that in Iceland we allowed the banks to fail. These were private banks and we didn't pump money into them in order to keep them going; the state should not shoulder the responsibility," he said.

The comments came just as the EU authorities were ruling out investor "haircuts" in Ireland, making this a condition for the country's €85bn (£72bn) loan package.

The Irish press reported that EU officials "hit the roof" when Irish negotiators talked of broader burden-sharing. (how dare German, British, or French global banks take a loss!?!) The European Central Bank is afraid that any such move would cause instant contagion through the debt markets of southern Europe.

Now this part is true - Iceland is tiny, so it is difficult to compare and contrast with any other country but I still think the principles hold.

Comparisons between the Irish and Icelandic banks must be handled with care. Iceland is tiny. It could walk away from liabilities equal to 900pc of GDP without causing a global systemic crisis. Ireland is 12 times bigger. The balance sheets of Irish banks are $1.3 trillion (£822bn).

The interlocking ties with German, Dutch, Belgian, and British banks create a nexus of vulnerability. Bondholder defaults would risk contagion to Spain and Portugal, where the banks rely heavily on foreign capital markets.

The reality is, if multiple countries default and insist on haircuts - many of the current mega banks would most likely all go kaput. This could be orchestrated but it would be difficult, because it would require political coordination across the globe to manage it as I described above. But it is not impossible - again the banks go bankrupt, they need not cease to exist after a reorganization.

Iceland also benefited because like the U.S., U.K., or Japan can play games with its currency - unlike the folks joined at the hip in the Euro.

Of course, banks are only half the story. Nobel economist Paul Krugman said Iceland has been able to eke out recovery sooner because it never joined the euro. "Iceland devalued its currency massively and imposed capital controls. And a strange thing has happened: although it experienced the worst financial crisis (anywhere) in history, its punishment has been substantially less than that of other nations," he said, referring to Baltic states pegged to the euro.

Two years later, the krona is down 30pc, aluminium smelters are firing on all chimneys to meet export demand and local produce has displaced imports, including such exotica as vegetables and tomatoes grown in greenhouses.

Is losing 30% of value of currency a great thing? No, but of the 2 choices of generations upon generations of taxpayer support to the oligarchs, or a severe one time hit and then a clean slate - most rational people would take a one time hit.

Ireland cannot resort to exchange and monetary stimulus without leaving the euro, which would be traumatic for all kinds of reasons, and illegal according to the ECB.

.....the underlying tale of Ireland and Iceland, and the tale of the 1930s, is that a devaluation shock may cause a violent crisis – that looks and feels terrible while it happens – but the slow-burn of policy austerity and debt deflation does more damage in the end.

“We’ve basically gone back to 2003 in terms of the level of standard of living,” he said. The worst has been felt by younger people who borrowed at the height of the bubble and are now having to reduce their debt, he said. “But they’ll come through this,” he added

One could argue many Americans have fallen back to a 2003 standard of living... or 2000 depending on your location and occupation. And what to show for it other than oodles of debt to service in the coming century.

Iceland’s experience, he said, offered a lesson for the euro zone as it grappled with its own crisis: “This is the proper process. If you go through a bubble economy and you need to correct it, the answer is not to convert private debt into public debt. Rather it is to restructure the debt to the level of the assets.”

Krugman's views:

"Bankrupting yourself to recovery! Seriously," Mr Krugman wrote in a New York Times column.

"In a nutshell, Ireland has been orthodox and responsible -- guaranteeing all debts, engaging in savage austerity to try to pay for the cost of those guarantees, and, of course, staying (with) the euro," the Nobel laureate wrote.

"Iceland has been heterodox -- capital controls, large devaluation, and a lot of debt restructuring," he said, summing up that as things stand now "heterodoxy is working a whole lot better than orthodoxy".

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